As it turns out, CEO pay is tied to company performance. It is all relative, however, and when companies perform poorly, executives are increasingly seeing their compensation reflect that lack of performance.
In 2008, the total compensation of the top 50 highest paid public company CEOs in Washington dropped 30 percent to $143.1 million as bonus payouts, long-term incentive grant values and other compensation declined significantly. On average, total CEO compensation was $2.9 million, down $1.2 million from 2007.
All components that make up a CEO’s compensation declined in 2008. This large drop in total compensation was driven by a $1,091,630 decrease, on average, in the value of long-term incentives, such as stock option grants or restricted share awards, along with a $63,012 reduction in actual bonus payments and a $31,913 reduction in other income compensation. The drop in long-term incentives awarded can be attributed to a change in the composition of the Top 50 companies, the absence of large one-time equity grants such as occurred in 2007 and a general decline in grant values. Many businesses had disappointing performance in 2008, also resulting in an 11 percent decrease in bonus payments.
Eleven CEOs did not earn any bonus in 2008. The 27 percent decrease in other compensation follows a national trend that is the result of media exposure of executive perks as well as recent federal requirements to disclose such perks in detail (see figs. 1 and 2 below).
Long-term incentives comprised 60 percent of the average CEO’s total compensation, versus 69 percent in the prior year. The composition of long-term incentives changed significantly in 2008 as the trend toward performance-based awards slowed. The portion of total long-term incentives attributable to performance shares decreased to 25.5 percent from 30.4 percent in 2007, but was still up from 13.2 percent two years ago. Although stock options still represent the largest portion of total long-term incentives, they continued a five-year trend of losing ground to other forms, declining to 41.6 percent in 2008 versus 44.8 percent in 2007. Increases in restricted shares offset the declines in performance shares and options, rising to 27.5 percent in 2008 from 21.9 percent in 2007 (see fig. 3 below).
The highest paid CEO in 2008 was Mark Pigott of Paccar, who earned $12.5 million in total compensation. Though he was not paid a bonus in 2008, he did receive $6.4 million in performance shares to match the value of 150,000 shares that he chose to hold after exercising options. For Piggott to earn the performance shares, Paccar’s earnings per share growth must exceed that of its peers—11 companies in similar industries listed in Paccar’s public filings for purposes of comparison, including Caterpillar, Deere & Co., Honeywell International and Harley-Davidson—over the next five years. Dawn Lepore of Drugstore.com was the biggest gainer on the list, rising 37 places to 13th highest-paid in 2009 from 50th in 2008. REPORTING UNDER NEW DISCLOSURE RULES This is the second year in which all companies reported under new federal disclosure rules.
We continue to rank CEOs by summing up base salary, actual bonus earned, the value associated with the opportunity of earning a long-term incentive payment and all other compensation with the exception of pension and deferred compensation. Companies that had performance-based incentive payments were required to disclose the related minimum, target and maximum award values. Discretionary payments had no disclosure requirements concerning targeted amounts.
Thirty-seven companies reported targets for annual incentives indicating they had performance-based plans. More than half of the CEOs had a bonus target above 86 percent of their base salary and fully one quarter had targets equal to or greater than their base pay. PAY FOR PERFORMANCE For those companies reporting targets and actual amounts earned, we were able to calculate a bonus achievement rate (actual bonus amount divided by target bonus amount). Investors can assess the link between pay and performance by comparing a company’s bonus achievement rate to its financial performance (see fig. 4 below). Comparing bonus achievement rate against annual returns to shareholders, it appears that there is a link between bonus and financial performance.
We would generally expect CEOs who earned more than the targeted award to have performed well relative to their peers. The top 50 CEOs’ actual bonuses as a percentage of target values were 74 percent in 2008 versus 77 percent in 2007.
Eleven of the 37 companies that reported a target bonus amount paid no bonus at all, including Paccar, Starbucks, Itron, Blue Nile, TrueBlue, Eddie Bauer and Nordstrom. The average annual return to shareholders for the target reporting group was minus 40 percent compared with a positive 5 percent return in the prior year.
Long-term incentives also provide a strong link to performance. The value of those incentives on the day they were granted was 39 percent lower in 2008 compared with 2007. In the prior year, there were a number of large one-time grants, and their absence attributed to the drastic decline of incentive awards in 2008.
Not only were the stock options granted to executives worth less to begin with, in most cases, their value declined significantly by the end of the fiscal year as a result of the plunge in stock prices. The result was that most of the options granted were underwater, and the target value of the performance shares and time-restricted shares declined significantly. The sum of the year-end, in-the-money value of the stock options, value of performance shares at target and time-restricted stock granted in 2008 totaled $33 million compared with the grant date value of $81 million. It is true that the affected executive has time to recover from this paper loss, but we can assume the initial drop in value has not gone unnoticed.
This year’s findings support the conclusion that there is pay for performance at Washington companies.
List: The 50 Highest Paid CEOs in Washington
Linda Steffen is a senior consultant with the Northwest compensation consulting practice of Watson Wyatt Worldwide, a leading global human capital consulting firm.